VZCZCXYZ0008
RR RUEHWEB

DE RUEHVB #0025/01 0090759
ZNR UUUUU ZZH
R 090759Z JAN 06
FM AMEMBASSY ZAGREB
TO RUEHNO/USMISSION USNATO 3425
RUEHC/SECSTATE WASHDC 5503

UNCLAS ZAGREB 000025 
 
SIPDIS 
 
SENSITIVE 
SIPDIS 
 
NATO PLEASE PASS TO LT. GENERAL HANLON 
 
E.O. 12958: N/A 
TAGS: OREP PREL PGOV MARR HR
SUBJECT: Croatia Scene Setter for Lt. General Hanlon 
 
 
¶1. SUMMARY: The last few months have brought a string of 
good news for Croatia and the government of Prime Minister 
Ivo Sanader.  With EU accession negotiations opened on 
October 4 and fugitive general Ante Gotovina arrested in 
Spain on December 7, Croatia has now cleared the major 
political obstacles in its path to Euro-Atlantic 
integration.  What remains are the more difficult agendas of 
defense and economic reform.  As a candidate for NATO 
membership, Croatia now needs to make serious progress in 
the area of defense reform and demonstrate that it can 
become a net contributor to the Alliance's new missions.  On 
the economic front, Croatia has made steady, albeit uneven 
progress in enacting the reforms necessary for it to keep 
pace with its more advanced northern neighbors.  Ten years 
after the end of the war, Croatia still lags in attracting 
vital foreign investment because of an ineffective legal 
system, rigid socialist-legacy labor laws and bureaucratic 
inertia.  Our goal is to help quicken the pace of reform and 
make Croatia a source of stability and economic prosperity 
in the region.  The U.S. fully supports Croatia's 
aspirations to join NATO and the EU.  END SUMMARY. 
 
THE NEW FACE OF THE NATIONALIST PARTY 
------------------------------------- 
 
¶2. Croatia's current government is led by the Croatian 
Democratic Union (HDZ) party of PM Ivo Sanader, elected in 
November 2003 on a platform promising to bring Croatia into 
the EU and NATO.  The HDZ has proven it is no longer cut 
from the same cloth as the nationalist HDZ of the late 
president Franjo Tudjman in the 1990s.  PM Sanader made 
important gestures immediately after taking office, such as 
visiting the Serb Community on Orthodox Christmas, reaching 
out to the Muslim minority, and signing coalition agreements 
with the Serb parliamentary grouping -- things almost 
unthinkable just months before.  In addition, he has made 
great strides in normalizing relations with Serbia and 
Montenegro and Bosnia and Herzegovina, including high-level 
visits, visa-free travel and free trade agreements. 
 
¶3. The opening of EU accession negotiations on October 4, 
2005 was a major victory for the Sanader government. 
Croatia cleared a further hurdle on December 7, when 
fugitive general Ante Gotovina was arrested in Spain and 
transferred to the ICTY in The Hague to stand trial for 
charges of war crimes committed in the aftermath of 
Croatia's Operation Storm, which liberated the Serb-occupied 
Krajina region in 1995.  The Gotovina arrest, applauded by 
the U.S. and the international community, was generally 
unpopular domestically, as many Croats consider Gotovina a 
hero of their war of independence.  However, it appears 
unlikely that this arrest will inflict lasting political 
damage on Sanader, as it was largely expected after 
Gotovina's four years on the run.  Protests, which died down 
after only a few days, were peaceful and generally smaller 
than expected. 
 
EURO-ATLANTIC INTEGRATION: NOT IF, BUT WHEN 
------------------------------------------- 
 
¶4. Croatia is making progress in its stated goal of NATO 
membership, particularly with Gotovina now in The Hague. 
There is a general consensus among the political elite that 
Croatia belongs in NATO, but this is not matched by similar 
levels of support among the general public.  Over the 
summer, the parliament approved tripling to 150 Croatia's 
troop (currently primarily Military Police) contribution to 
NATO's ISAF mission in Afghanistan.  A Croatian MP platoon 
is currently in its sixth rotation in Kabul and the first 
increase in ISAF contributions will be a demining unit to 
deploy with the Lithuanian PRT in Chagcharan.  Currently, 
Croatia has 30 persons deployed on 10 UN peace support 
operations, including Major General Dragutin Repinc, who 
assumed command on December 29 of the UNMOGIP operation in 
Kashmir. 
 
¶5. Croatia has an ambitious military reform program in place 
to make the armed forces "NATO-ready" by 2007 - a difficult 
task under the best circumstances.  The government signed 
off earlier this year on the Stategic Defense Review, which 
bases future defense planning on the assumption that Croatia 
has no serious threats to its territorial integrity and will 
be a full partner in collective defense through NATO.  The 
Long Term Development Plan for the Croatian Armed Forces, 
currently in semi-final draft form, attempts to bridge the 
gap between the defense reform vision of the SDR and the 
likely fiscal shortfalls over the next three-five years. 
Defense spending is currently just short of the Prague 
Capabilities Commitment level of 2 percent of GDP, although 
massive pension payments to war veterans and a personnel- 
heavy defense budget leave only minimal resources for much- 
needed equipment procurement.  U.S. firms, including 
Lockheed-Martin, ITT and Motorola are supplying equipment to 
the Croatian military and General Dynamics and Raytheon are 
currently bidding on contracts for the major, upcoming 
purchase of armored personnel carriers.  We support 
Croatia's NATO ambitions, but have been very clear in our 
message that defense reform is an essential pre-condition 
for Croatia to demonstrate that it will become a net 
contributor to security through NATO operations. 
 
THE WAR IS OVER, BUT THE SCARS REMAIN 
------------------------------------- 
 
¶6. Among the more important accomplishments of PM Sanader's 
government are advances in addressing the legacy of the 1991- 
95 war.  In addition to improvements in cooperation with the 
ICTY and general adjudication of war crimes, the HDZ 
government has made significant progress on refugee returns 
based on its December 2003 coalition agreement with Serb 
partners.  International observers such as the OSCE and 
UNHCR have praised the government's pace of reconstruction 
of war-damaged housing and return of refugee property, but 
believe progress is still needed in the areas of housing for 
those who lost socialized housing, electrification of 
reconstructed villages, compensation for looted property, 
and minority representation in the judiciary, police force, 
and government administration.  Discrimination and 
resistance to change at the local level are persistent 
challenges. 
 
¶7. Of the estimated 350,000 people, mostly ethnic Serbs, who 
were displaced during the war, about 134,000 have returned. 
This leaves approximately 215,000 refugees and internally- 
displaced persons derived from the 1991-1995 war - most of 
these ethnic Serbs now living in Serbia and Montenegro and 
Bosnia and Herzegovina.  A recently completed UNHCR re- 
registration project clarified the number of true refugees, 
concluding that approximately half, or 110,000, actually 
intend to return to Croatia. 
 
¶8. As suggested by the OSCE, UNHCR, and the European 
Commission, the Government has created a "road map" with the 
goal of closing the refugee file in 2006.  Elements of this 
include specific benchmarks such as the resolution of 
refugee housing, equal access to information and government 
services, and information on war crimes indictments. 
 
ECONOMY: BETTER, BUT MANY TOUGH CHOICES AHEAD 
--------------------------------------------- 
 
¶9. Croatia missed out on the initial rush of foreign 
investment in Central and Eastern Europe following the fall 
of the Berlin Wall, largely because of the war in the former 
Yugoslavia, but also because of its slowness to make the 
difficult but necessary decisions to reform its economy.  As 
such, although its per capita GDP of approximately $7,800 is 
over twice that of Serbia and Montenegro, it is only half 
that of its northern neighbor Slovenia.  In recent years, 
the country has seen general macroeconomic stability, with 
low inflation and steady growth.  Unemployment, however, 
remains stubbornly high at approximately 14 percent. 
 
¶10. Although there has been progress in shedding some of the 
state's still large portfolio of assets, notably banks, 
hotels and large agricultural combines, the government 
continues to be saddled with loss-making industrial 
companies whose subsidies drain approximately 3 percent of 
GDP annually.  As a percentage of GDP, the state's role in 
the economy is far above the EU average at nearly 40 
percent.  With one pensioner for every 1.4 persons employed, 
above-average healthcare costs and out of control 
entitlement programs, the government faces many necessary, 
but politically unpopular decisions if it is to reduce 
chronic deficits and liberalize the country's economy. 
 
¶11. Croatia has lagged in attracting foreign direct 
investment, particularly American investment.  This is 
attributable to several factors, most notably an inefficient 
judicial system that can take years to resolve even the most 
basic commercial disputes and a stubbornly Byzantine 
bureaucracy.  We have seen some improvement in this last 
area, with the government's creation of a "one-stop shop" 
for business registration and a trade and investment 
promotion agency to assist prospective foreign investors. 
We are cautiously optimistic that the government will follow 
through with promises to build on these initiatives and that 
judicial reform efforts will bear fruit. 
 
¶12. Croatia's EU neighbors are its largest trading partners 
and Croatia runs trade deficits with nearly all of them, 
with imports doubling exports at roughly $16 billion 
annually.  Trade with the U.S. is relatively small in 
comparison, approximately $400 million in 2004, as opposed 
to $4.5 billion with Italy and nearly $2.0 billion with 
neighboring Slovenia.  In a hopeful sign of regional 
reconciliation, Croatia's trade with both Bosnia and Serbia 
has shown strong growth this year. 
 
¶13.  Croatia's political elite is fully cognizant of the 
need to reform the economy and has made some recent progress 
in that direction.  However, much more remains to be done if 
the country is to begin to reach the levels of growth and 
investment enjoyed by its northern neighbors.  Now that 
Croatia will begin EU accession negotiations, it is possible 
that EU pressure will provide the government with sufficient 
political cover to tackle some of these difficult issues.